S&P 500 closes flat as strong earnings offset by trade war fears

It would be wonderful if we could avoid the common setbacks with timely exits. – Peter Lynch

It was a tug of war last week between second quarter corporate earnings reports on one side and continued talk of increased tariffs and trade war fears on the other side. When the markets finally closed on Friday, neither side could declare victory as the major stock averages barely budged. The S&P 500 Index rose less than one point for the entire week, about as flat as the market could be for five trading days. On the positive side, quarterly earnings continued to be strong across all of the major industry groups. The only disappointment last week may have been Netflix reporting a big miss on its subscriber growth but the company still managed to top earnings estimates. Blue chips such as Bank of America, Goldman Sachs, Johnson & Johnson, Abbott Labs, Microsoft and IBM all beat earnings projections and reported strong revenue growth as well. While only 15% of S&P 500 companies have announced their profit results for the second quarter, nearly 95% of them have exceeded expectations. Earnings growth is expected to be about 20% for the quarter compared to 24% in the first quarter. That certainly is a high bar for companies but so far they have been up to the task. The week was not without its share of negative developments, though. President Trump said that he was prepared to impose tariffs on all $505 billion of Chinese goods imported into the U.S. in order to combat China’s unfair trade practices. In his testimony before a Senate committee, Federal Reserve Chairman Jerome Powell was concerned about the harmful effects that tariffs would have on economic growth. Trump even criticized the Fed’s monetary policy, saying he wasn’t happy with the recent interest rate hikes and the plan to raise rates again this year. His contention was that higher rates would undermine the economy and detract from the benefits of lower corporate and individual tax rates. As long as the political noise doesn’t become too loud and obtrusive, continued better than expected corporate earnings should eventually win out and provide support for the stock market.

Last Week

Retail sales for June were strong and slightly better than expected and June leading economic indicators were also slightly better than forecast as they registered their eighth straight month of gains. This trend should portend continued solid growth in the U.S. economy. Weekly jobless claims fell by 8.000 to 207,000, lower than forecast, and the lowest level in nearly 50 years.

The Federal Reserve’s Beige Book cited growing wage pressures from a tight labor market and showed a shortage of workers across a wide range of occupations.

For the week, the Dow Jones Industrial Average rose 0.2% to close at 25,058 and the S&P 500 Index closed flat at 2,801. The Nasdaq Composite Index fell 0.1% to close at 7,820.

This Week

Existing home sales for June are expected to exceed those reported in May while new home sales are expected to be slightly less. June durable goods orders are forecast to rebound strongly after declining in May. Second quarter gross domestic product (GDP) is expected to be 3.8%, nearly double the growth rate in the first quarter.

The European Central Bank (ECB) is not expected to change its monetary policy and negotiators from the U.S., Canada and Mexico are scheduled to restart talks on renegotiating the North American Free Trade Agreement (NAFTA).

Among the most prominent companies scheduled to report earnings this week are AT&T, Verizon, Alphabet (Google), Facebook, Amazon.com, Intel, Amgen, Merck, Eli Lilly, 3M, General Motors, Ford Motor, Boeing, United Technologies, McDonald’s, Starbucks, Chevron and Exxon Mobil.

Portfolio Strategy

As if investors didn’t have enough to worry about, President Trump lashed out at the Federal Reserve last week by saying he wasn’t “thrilled” by the Fed’s rate increases so far this year. He also criticized their intention to raise interest rates two more times in 2018 and thought the tighter monetary policy was causing the dollar to rise, hurting trade by making U.S. exports more expensive to foreigners. He even questioned why the Fed would raise rates in the face of staggering national debt and a huge U.S. budget deficit. The current federal funds rate is in a range of between 1.75% and 2.00%, which is low by historical standards. With the Fed determined to normalize monetary policy, it has signaled two additional rate hikes, bringing the range to 2.25% to 2.50% by year-end. The increases are not forecast to stop there, either, as at least two more rate hikes are planned for next year. The Federal Reserve has always maintained its independence to formulate monetary policy based solely on economic considerations and nothing else. If Fed Chairman Jerome Powell continues to raise rates, he may face criticism from both political parties that aggressive tightening isn’t necessary, especially if inflation remains under control. But if the Fed backs off and slows the pace of interest rate hikes, Powell may be criticized for bowing to political pressure, even if economic conditions warrant it. The President should keep his thoughts about the Federal Reserve to himself and let Fed Chairman Powell and his committee make policy decisions by themselves with no outside interference.